Prioritize Debt to Pay Off Debt Faster

Q: I have a fairly complicated situation but I’ll make it as simple as possible. I have some debt and I’m wondering how to prioritize it.

I have a second loan from a past foreclosure for $32,000. I have been negotiating with the bank (through my attorney) and the settlement price has come down to $15,000 after a year of offers. I have not accepted or refused anything yet. The debt is still pending.

I also own a motor home. The loan is for $52,000 at an 8 percent interest rate, with a monthly payment of $576. Unfortunately, my motor home is underwater, so selling is not an option. I would have to pay at least $20,000 to cover the loan.

I own a condo in Atlanta. I have a $155,000 interest-only loan on the property with a monthly payment of $772. I plan on living here for a long time. The condo is upside down and today is probably worth only $100,000.

Additionally I have been audited for the past four years in a row and am currently in the tax appeals court process for. And, I don’t have any credit card debt.

I do earn a good living. I’m a freelance camera operator and I earned about $120,000 in 2011 but anticipate earning only about $80,000, after expenses, in 2012. I have $48,000 in a brokerage account, $40,000 in a Roth IRA, and about $5,000 in savings.

Can you tell me if you see any red flags here? I’ve never missed payments on my motor home or condo. What should my current financial goals be?

A: You’ve clearly made some questionable financial decisions in the past. The good news is that you earn a substantial amount of money for a single guy (I’m making that assumption since you don’t mention a spouse or family in your email). The question for you is what are you doing with all of your earnings?

If you’re earning $120,000 or even $80,000 after expenses, that’s a substantial sum. Your debts don’t amount to much with that kind of purchasing power. Your monthly mortgage expenses (excluding the $32,000 foreclosure debt) are about $1,300. You’re bringing in about $6,700 per month (gross), which after your taxes (including self-employment tax) are deducted amounts to about $4,000 per month.

You ought to be able to set aside enough cash to nearly pay off the $15,000 second loan from the foreclosure in the first year. The only caution there is you will likely get hit with a tax bill for the debt that is being forgiven ($17,000) by the lender the following April 15. You’ll need to set aside funds to pay the taxes on the debt that’s released.

As for the motor home, it sounds as though you’re stuck with that for the time being if it is worth about $20,000 less than you paid for it. That sounds like an impulse buy and with gas prices nearing $5 per gallon (that’s almost what we paid in California recently), it’s easy to imagine that motor home not generating a whole lot of interest from prospective buyers.

As for your condo mortgage, you should keep paying that one, too. If you want to live in that condo for a long time, it doesn’t matter how far underwater it is. You didn’t tell me what the interest rate is, but it doesn’t appear to be much. The concern is that you bought that condo at the top of the market, and now aren’t building any equity in it. You’ll want to rethink that plan as soon as you take care of the foreclosure loan. And, at some point in time, your interest-only loan is going to convert into a one-year adjustable rate mortgage (ARM). But you’re not really eligible to refinance that property right now, so let’s not worry about it.

So here is your best course of action: Keep current on your payments and agree to the $15,000 payoff of the foreclosure loan. See if the lender will allow you to pay it off in monthly payments of $750 or $1,000 over the next year and a half. With some belt-tightening, that should fit into your budget. Make sure the lender agrees (in writing) to inform credit reporting bureaus that the loan is “paid as agreed.” That should help your credit history and score.

Once you pay that foreclosure loan off, turn those extra payments toward paying down the motor home loan. You need to get that loan even so that you can unload the motor home and stop making those monthly payments. Hopefully, your income will rise in 2013, and you will be able to throw even more money at that loan. If you’re lucky, it will take less than 18 months to get to even with that loan. Then, go ahead and sell the motor home.

In three years or so, you should be sitting pretty. You’ll have just the condo and whatever other expenses you have in your life. But two big debts will be gone and you’ll be able to resume saving for emergencies and retirement. While pulling in your belt doesn’t sound like much fun, it’s a heck of a lot better than living with all this debt.

If you need help in figuring out where to spend less money, get in touch with a non-profit credit counselor, like the folks at Credability.org.